The private equity premium puzzle: a behavioural finance approach

Abstract

This paper adds new insights on the specificities of entrepreneurs, by focusing on the specificity of entrepreneurs' financial behaviour. First, we provide a detailed review of the literature on the private equity premium puzzle. This review underlines that, from a financial perspective, entrepreneurs differ from non–entrepreneurs because of the low, according to financial theory, risk–return trade–off of their asset portfolio. Our analysis of the literature shows that the higher risk tolerance of entrepreneurs is not sufficient to explain the private equity premium puzzle. Therefore, we apply behavioural finance in order to explain why entrepreneurs, who are aware of their high risk exposure, do still accept low returns. We show how cognitive biases can explain the private equity puzzle. Moreover, we highlight that this puzzle can be understood in light of cumulative prospect theory (Tversky and Kahneman, 1992) and behavioural portfolio theory (Shefrin and Statman, 2000) findings.